UK: All Change For Main Market Auditor Appointments

Changes to the audit requirements for public interest entities
(PIEs) take effect on 17 June 2016 under a new EU Audit Regulation
and as a result of amendments made to the EU Statutory Audit
Directive, implemented in the UK by the Statutory Auditors and
Third Country Auditors Regulations 2016.

In addition to credit institutions and insurance undertakings,
PIEs include companies with transferable securities admitted to
trading on a regulated market (traded companies). This will
therefore include companies admitted to the Official List and
traded on the main market of the London Stock Exchange, but will
not include AIM companies.

Consequential changes will be made to DTR 7, to the UK Corporate
Governance Code and the Guidance on Audit Committees published by
the Financial Reporting Council (FRC).

Some of the more significant changes are summarised below.

Auditor appointment

The Companies Act 2006 has been amended, for the first time
setting out in statute the role of the audit committee in relation
to auditor appointments and providing for mandatory auditor
rotation and competitive tendering.

A UK incorporated traded company must retender its audit
engagement at least every ten years, unless it is a small or
medium-sized enterprise or a company with reduced market
capitalisation for the purposes of the Prospectus Directive.

The audit committee must make a recommendation to the board as
to the choice of auditor. In years where there has been a
tender process, the audit committee must identify its first and
second choices in its recommendation, and state that its
recommendation is free from influence by any third party and that
no contractual restriction on its choice of auditor has been placed
on the company.

Following the audit committee recommendation, the board proposes
an auditor for appointment by the company in general meeting.
The board must include in its proposal details of the audit
committee's recommendation and, if its proposal does not accord
with that recommendation, the reason for that.

The auditors will be subject to a maximum engagement period of
10 years. This is extended to 20 years if the audit firm was
first appointed following a tender process, and was reappointed
pursuant to a tender process after a maximum of 10 years. The
FRC can, in exceptional circumstances, extend the maximum
engagement period by a further two years.

Transitional provisions apply so that where an audit firm has
been in office since before 17 June 1994, the company must change
its auditors by June 2020. Where an audit firm has been in
office since before 17 June 2003 (but on or after 17 June 1994),
the company must change its auditors by June 2023.

An audit firm which has reached the end of its maximum
engagement period cannot be reappointed as auditor within four
years, nor can any person in its network.

These provisions sit alongside the competitive tender process
previously imposed on FTSE 350 companies by the Statutory Audit
Services for Large Companies Market Investigation (Mandatory Use of
Competitive Tender Processes and Audit Committee Responsibilities)
Order 2014, which continues to apply.

Contractual clauses restricting the company's choice of
auditor are prohibited, and existing contractual restrictions are
void. This prohibition applies from 17 June 2016 to companies
which are not PIEs including, for example, a traded company's
UK subsidiaries. Technically, it will not apply to PIEs until
17 June 2017. However, from 17 June 2016 the audit
committee of a PIE is required to state, when recommending an
auditor for appointment, that no such clause has been imposed on
it. This means that, in practice, the prohibition will also
apply to PIEs from the earlier date. From 17 June 2017, a PIE
must inform the FRC if there is an attempt to improperly influence
its choice of auditor.

Audit fees and services

Contingent audit fees, calculated on a basis relating to the
outcome of a transaction or work performed, are prohibited.
Audit firms may not tender for non-audit services valued at more
than 70% of the average audit fee in the last three financial years
and, if total fees from a PIE for each of the last three financial
years is more than 15% of the audit firm's total fees, the
audit firm must disclose this to the PIE's audit committee and
discuss the threats to their independence.

The audit firm is not permitted to provide certain services to
the PIE, including certain tax services, payroll services, services
relating to the internal audit function and certain legal and human
resources services. Other non-audit services may be provided
if the audit firm has properly assessed any threats to its
independence.

The audit firm must give an annual written confirmation of
independence to the audit committee.

The audit report must include a statement on any material
uncertainty relating to events that may cast significant doubt
about the company's ability to continue to adopt the going
concern basis of accounting, and the audit firm must deliver a
detailed report to the PIE's audit committee along with, or
before, the audit report.

The audit firm must report to the FRC any material breach of
laws or regulations by the PIE, and doubts about its continuous
functioning or the issuing of an adverse or qualified audit
opinion.

Removal of auditors

The Companies Act 2006 has been amended so that the court may
remove the auditors of a PIE on the application of the FRC, or on
the application of shareholders representing 5% or more of the
voting rights or the nominal value of the share capital of the
company. The court will remove the auditors if it is
satisfied that there are proper grounds, but a divergence of
opinion on accounting treatments or audit procedures will not be
sufficient.

Amendment to DTR 7 and the UK Corporate Governance Code

Consequential amendments to DTR 7 are proposed, to take effect
for financial years beginning on or after 17 June 2016:

The independence requirement will apply to a majority of the
members of the audit committee, rather than at least one
member.

The members of the audit committee as a whole will be required
to have competence relevant to the sector in which the company is
operating.

The audit committee chairman must be independent and must be
appointed by the members of the audit committee or by the
board.

The responsibilities of the audit committee have been
extended.

The UK Corporate Governance Code is also amended, for financial
years beginning on or after 17 June 2016, to provide that the audit
committee as a whole must have competence relevant to the sector in
which the company operates. The revised Code also includes a
requirement for the annual report to include advance notice of any
external auditor retendering plans. The FRC has also updated
its Guidance on Audit Committees.

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.

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